SRJC_H2_ECONS_9757_Q4_MS

Explain the domestic and international factors that could cause deflation. [10] Introduction: Definition: Deflation is a sustained decrease in the general price level of an economy, or negative inflation rate. Direction of essay: This essay aims to explain how deflation occur due to a persistent fall in AD and/or persistent increase in AS that arises due to domestic factors and/or international events that is beyond a country’s control. P1: Deflation could be due a decrease in th e components of AD that results from domestic factors. E/E: A decrease in AD can be caused by a decrease in any of the components of AD – consumption expenditure (C), investment expenditure (I), government expenditure (G) and/or net exports (X-M) that arises due to domestic situation in the country. For example, when an economy experiences a recession, consumers would probably reduce their consumption expenditure (C) as the risk of losing their jobs increases. There will also be a fall in investment as recession usually result in lower business confidence as investors are uncertain about their future returns on their investment. As both investor and consumers demand lesser quantity of products a t each given price level during recession, there will be a leftward shift of AD from AD0 to AD1, resulting in a surplus at the original general price level. Due to the surplus, there will be a downward pressure on the general price level from P0 to P1. L1: However, if consumers expect a further fall in general price level in the future, they will start to hoard money, delaying consumption in anticipation of lower price in the next period. Business would see it as a fall in demand and will postpone investment. This will further decrease AD, which will bring about a further fall in general price level, hence resulting in a deflationary spiral, whereby the economy cannot recover, leading to ev en lower prices in a vicious cycle. P2: Deflation could be due a decrease in the components of AS that arises from domestic factors. E/E: An increase in AS can be caused by a fall in cost of production due to increase in labour productivity within the country. As Singapore is shifting towards a more technology -enabled Y0 0 AD1 AD2 Real National Income AS General Price Level P0 P1 Y1 Fig 1.

operation due to subsidy given to firms to engage in R&D. With greater use of capital goods, it means an increase in efficiency as it will help to increase labour productivity as more output could be produced within the same man/hr. Moreover, during the period 2004 to 2014, Singapore relaxed her immigration policy to attract foreign workers and immigrants. The increase in the supply of foreign workers in Singapore have resulted in an increase in labour productivity and productive capacity, causing a rightward shift of LRAS. L2: Deflation will only